Skype Investors Will Reap a Windfall

By

Spencer E. Ante

Updated May 11, 2011 4:48 p.m. ET

The handful of investors who acquired a majority stake in Internet communications provider Skype Global during the depths of the financial crisis stand to be handsomely rewarded by its $8.5 billion sale to
Microsoft
Corp.

History of Skype

And some investors did better than others. The biggest winner is private equity firm Silver Lake Partners, the largest current shareholder of Skype with about 39% of the Luxembourg-based company. The second largest shareholder is
eBay
Inc.,
which held on to a 30% stake in the company after selling most of it in 2009 to the current investor group.

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Other winners include the Canada Pension Plan Investment Board, which owns about 12%; venture capital firm Andreessen Horowitz, the smallest shareholder at 3%; and Joltid Ltd., an investment company partly owned by Skype founders
Niklas Zennström
and
Janus Friis,
which owns 14%. Messrs. Zennström and Friis each own 18.75% of Joltid directly, according to filings with the Securities and Exchange Commission.

Silver Lake managing director
Egon Durban
said its nearly $1 billion Skype investment was the largest equity investment in the Menlo Park., Calif., firm's history. With the sale, Mr. Durban said Silver Lake would receive more than three times its original investment, turning a profit of at least $2 billion. "We had the courage and conviction to invest when no one was investing capital," said Mr. Durban.

EBay, which initially lost money on its Skype acquisition, will end up with a sizeable profit. In 2005, the company paid about $2.6 billion for Skype and subsequently laid out another $530 million in earn-out payments. It later took a $1.4 billion writedown of the investment in 2007. Two years later, the online marketplace sold a 70% stake in the company for $1.9 billion to the investor group. After the Microsoft purchase, eBay's 30% stake will be worth approximately $2.55 billion. It will also receive an additional $125 million for a loan it gave to Skype's investors.

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An eBay spokesperson said the deal "gives our shareholders a strong return of approximately $1.4 billion on our original investment for a dynamic business that simply wasn't core to our focus on global payments and commerce."

The Canada Pension Plan invested $300 million for a 15% stake in Skype, which was later diluted to around 12%. A spokeswoman for the plan says it expects to receive approximately $930 million for its stake. In addition, the plan invested $50 million in Skype indirectly through funds managed by Silver Lake. That stake should return about $155 million, before management and investment fees.

Andreessen Horowitz invested about $50 million, and more than tripled its money, said a person familiar with the matter. "People have underestimated Skype and they haven't appreciated the value of it," said
Marc Andreessen,
cofounder of the venture capital firm.

The story of Skype is a dramatic tale filled with twists and turns. Skype was founded in 2003 by Mr. Zennström and Mr. Friis who sought to create a company that let people make phone calls over the Internet instead of traditional copper lines. The free service took off as many consumers and businesses began to use it to get around expensive international calling rates. Calls to other users of Skype are free, while calls to traditional landline phones and mobile phones are charged a small fee.

ENLARGE

Skype investors, left to right, Marc Andreessen, Niklas Zennström and Janus Friis will be well rewarded for their patience.
Bloomberg News (Andreessen, Zennstrom); Associated Press (Friis)

Former eBay Chief Executive
Meg Whitman
acquired its stake in the belief that Skype would help accelerate online sales if the buyers and sellers on the online-auction site used the service to communicate. But the synergies never materialized, even though Skype continued to grow its subscribers and revenue. EBay also continued to license Skype's peer-to-peer technology from Joltid. In 2007, eBay took a $1.4 billion charge for Skype because of the unit's shrinking value.

That disappointing performance led eBay's new CEO
John Donahoe
to pursue a new direction. In 2009, eBay said it planned to unload Skype in an initial public offering. Later that year in September, the company reversed course and sold a 70% stake in the Internet-phone business to investors, including Silver Lake, Andreessen Horowitz and the Canadian pension group.

The majority stake sale of Skype, which took place in middle of the global financial crisis, valued Skype at $2.75 billion, about the same price as eBay paid four years earlier. To complete the deal, Skype raised $825 million in debt to help finance the transaction. It was the first leveraged buyout since the demise of Lehman Brothers in the fall of 2008, according to private equity researcher Prequin. The deal allowed eBay to focus on its core business, retain 30% of the company and receive $1.9 billion in cash for the sale.

Soon after the sale, Joltid sued eBay, the investor group and Skype in the U.S. for copyright infringement of its technology, reaffirming a previous and similar lawsuit in the U.K. In November, eBay announced it and the investor group reached a settlement with Joltid that gave Skype ownership of all software previously licensed from Joltid.

As part of the settlement, Mr. Zennström and Mr. Friis joined the investor group, contributing Joltid software and additional capital in exchange for a 14% stake in Skype, taking shares from existing investors. Skype also said that it took a $344 million charge resulting from the settlement. That cleared the way for an IPO.

Last August, Skype registered to hold an initial public offering. Then in October, the company took the unusual step of naming a new CEO during the IPO process, appointing
Cisco Systems
Inc.
executive
Tony Bates
as chief executive. The change led the company this year to delay its IPO plans to the second half of 2011.

Six weeks ago Microsoft executives made an unsolicited call to Mr. Bates and Silver Lake's Mr. Durban, said people familiar with the matter. The companies began discussions and the final price was agreed upon on April 18.

Microsoft was the only serious bidder although Skype didn't close the door to other potential buyers, they said. A deals team from Microsoft conducted due diligence, but the process was made easier because much of Skype's financial information was already available via the IPO registration statement, filed last August. The prospect of an IPO helped Skype drive a harder bargain for Microsoft, one person said.

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